FHA Cash-Out Refinance Guidelines

The Federal Housing Administration (FHA) has evolved to fit the ever-changing needs of borrowers since its beginning in 1934. More lenient on credit guidelines than conventional lenders, FHA-insured loans have helped millions of families buy affordable homes with low down payments. FHA has also allowed borrowers to refinance those mortgages to decrease their interest rates and monthly payments, and to pull cash out for personal reasons.

Considerations

Until April 2009, a cash-out refinance could be as much as 95 percent of a home's loan-to-value amount. The housing bust of 2007 led to tighter requirements and stricter guidelines. FHA has made changes to preserve its program. Cash-out refinances closed after April 1, 2009, are limited to 85 percent of the property's LTV.

Borrower Requirements

The home must be owner-occupied, not used as investment property. The homeowner should have owned the home for at least 12 months to use the new appraised value, assuming that value is higher than the purchase price. The homeowner should have a satisfactory payment history for 12 months, with no payments more than 30 days late. The new payment created by the increased loan amount should fit within the borrower's debt ratios. Monthly housing debt -- principal, interest, taxes, homeowner's insurance, mortgage insurance and homeowners association dues -- may not exceed 29 percent of the borrowers' gross monthly income. The borrowers' total monthly debt -- consumer debt plus housing debt -- may not exceed 41 percent of the borrowers' gross monthly income.

Credit Requirements

In the past, FHA did not set credit score requirements for loans. Market turbulence has caused many changes. As of July 2010, FHA will not consider any loan with less than a 500 score. An FHA purchase loan with a credit score lower than 580 will require at least a 10 percent down payment. FHA-approved lenders who fund and sell these loans will sometimes impose their own credit score requirements, with many requiring at least a 640. Check with your broker or lender to see what its minimum score is regarding an FHA cash-out refinance loan.

Consolidation

A cash-out refinance is defined as a new loan that pays off the old mortgage, the closing costs and yields an additional amount for personal use. This amount, which is limited to 85 percent of the appraised value in an FHA cash-out refinance, can be used for any purpose. However, if your debt ratios are high, your strategy may be to consolidate debt within the cash-out. When debt ratios are recalculated with the new mortgage payment, you may be required to pay off certain debts to keep debt ratios close to the 41 percent total debt ratio. Your lender will discuss this with you in the beginning of the loan process. You may be asked to provide account statements of targeted debts so the closer can pay off the debt from the cash proceeds of the new FHA refinance mortgage.

Warnings

If you are considering a cash-out refinance using an FHA loan, bear in mind that FHA requires two calculations of mortgage insurance. The first amount is the up-front mortgage insurance premium of 2.25 percent of the loan amount, which can be rolled into the new loan balance. The second is the monthly mortgage insurance premium, which stands at a maximum of 0.55 percent for 30-year loans. Multiply the loan amount times 0.55, then divide by 12 to get the monthly amount. This monthly portion of MIP does come off when the LTV reaches 78 percent as long as five years of payments have been made and the loan is current at the time it reaches the 78 percent mark. The monthly MIP is not required on 15-year loans with an LTV under 90 percent.

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About the Author

Joey Campbell spent eight years in real estates sales and property management. She has been active in residential and commercial mortgage for the past 23 years in the Southeastern U.S. Campbell has attended hundreds of seminars, and has written and conducted workshops on subjects such as credit, debt excelleration and prequalifying for residential mortgages.